Higher Bond Yields Mean Higher Corporate Pension Funding Levels

The funding status of U.S. corporate pension plans increased in October, largely due to a reduction in liabilities stemming from an increase in discount rates, which were offset by negative investment returns. According to some trackers, pension funding status is at its highest point in decades.

High Interest Rates Fuel Improvements

According to WTW’s pension finance tracker, U.S. corporate pension funding is at its highest level since mid-2001, with the funding ratio of WTW’s benchmark plan increasing 1.1 percentage points to 110.5% in October.

The WTW Pension Finance Index tracks the performance of a hypothetical 60/40 plan. This benchmark portfolio recorded a negative 2.4% return in October, but pension obligations decreased by 3.4% for the month, resulting in the tracker’s pension funding increase.

According to Insight Investment, funded status for the top 100 U.S. corporate pension plans increased to 108.1% from 107.5% in the month. Insight Investment found that among the top 100 plans, assets decreased by 3.8% and liabilities decreased by 4.3%, resulting in a 0.6-percentage-point increase in the funded status of the average plan.

Agilis, in its pension funding briefing, reported that pension discount rates are at their highest since early 2010, rising to more than 6% for the first time in more than a decade. According to Agilis, pension plans either maintained or slightly improved their funded status in October, as liabilities declined more significantly than assets.

“Rates at the long end of the curve continued to push upward during October, with markets presumably buying into the Fed’s posturing of ‘higher for longer,’ said Agilis managing director Michael Clark in a statement. “These movements at the long end of the curve had a significant effect on discount rates, which are up approximately a full 1% from the middle of the year. This significant change in discount rates has an equally significant effect on pension liabilities, as most liabilities tend to move anywhere from 8% [to] 14% depending on the nature of the pension plan benefits and demographics.”

Clark’s statement also broached potential strategies for the year ahead.

“Looking ahead to 2024, pension plan sponsors will want to continue de-risking discussions, whether through liability-driven investment strategies or pension risk transfers (lump sums and/or annuity purchases),” Clark said in the statement. “For frozen plans, evaluating a potential plan termination should be on the radar.”

According to Aon, which tracks pension funded status for S&P 500 companies with defined benefit plans, the aggregated funded ratio for these plans increased to 103.2% from 102.4% in October. For the year, these funded ratios are up from 98.2%. According to Aon, pension assets declined 2.8% in October. With the 10-year Treasury rate increasing 29 basis points and credit spreads widening by 8 basis points, interest rates used to value pension liabilities increased to 6.16% in October from 5.79% in September.

Milliman, in its 100 PFI pension tracker, found that pension funding status for the largest 100 corporate pension plans rose 1.4 percentage points in October, to a 2023 high of 104.2%. A 36-bps increase in discount rates to 6.2% offset a 2.68 dip in October.

“October marked a new funding ratio high for the year,” wrote Zorast Wadia, author of Milliman’s report. “While plan assets fell for the third consecutive month, discount rates rose yet again, this time breaching the 6% threshold. In fact, discount rates have increased by 100 basis points over the last four months and haven’t been this high since May 2009, making this a very favorable economic environment for plan sponsors.”

Milliman projects pension funding status to increase to 104.4% by the end of 2023 and 105.2% by the end of 2025, assuming the current discount rate of 6.20% is maintained and assets return an annualized 5.8%.

In an optimistic scenario, with interest rates reaching 6.3% by the end of 2023 and 6.9% by the end of 2024, with annualized asset returns of 9.8%, funded ratios could climb to 106% at year’s end and 118% by the end of 2024. In a pessimistic scenario, assuming 6.1% and 5.5% discount rates in 2023 and 2024, respectively, and annualized returns of 1.8%, funded ratios would decline to 103% at the end of 2023 and 93% at year-end 2024.

Q3 Funding Also Up, Returns Down

According to the Wilshire Trust Universe comparison service for the year’s third quarter, institutional plans returned negative 2.42% in the quarter but are up 10.19% for the 12-month period ending September 30.

“The strength of the U.S. economy in the face of materially higher interest rates has led to ongoing recalibration of interest rate expectations, fueling a continued rise in bond yields,” said Jason Schwarz, president of Wilshire Advisors, in a press release. “All plan types outperformed a traditional 60/40 portfolio, while smaller plans with higher allocations to public markets generally underperformed larger plans by approximately 50-75 basis points.” 

Some Consultants See Funding Decline

Not every firm reported an increase in pension funding ratios. LGIM’s Pension Solutions Monitor reported that U.S. corporate pension funding ratios declined in October, to 102.2% from 102.6%,. A decline in equities resulted in a drop in assets that outpaced the drop in liabilities, according to LGIM.

According to October Three Consulting, pensions have endured declining equities and benefitted from higher interest rates for the last three months, and both of October Three’s tracked plans reported a decline in pension funding.

October Three’s Plan A, a benchmark plan with a traditional 60/40 asset allocation, declined a fraction of a percentage point in October but has returned 8% since the start of the year. Plan B, a largely retired plan with a 20/80 allocation, also declined a fraction of a percentage but remains up 1% year to date.